Don’t Forget the Risks of a Roth 401(K)

CHARLES ROTBLUT: The appeal of a Roth 401(K), and a Roth IRA, is the payment of taxes on contributions now versus the payment of taxes on appreciated capital in the future. If a person believes his tax rate will be higher in the future than it is now, a Roth account has appeal. Plus, a Roth 401(K) can be rolled over into a Roth IRA without incurring any tax liabilities so long as the conversion rules are followed (e.g. it must be completed within a 60-day window).

There are risks to consider, however. Roth account contributions are funded with post-tax dollars. Whereas every dollar contributed to a traditional 401(k) is only a $0.72 out of pocket expense (for someone in the 28% tax bracket), the same dollar contributed to a Roth IRA costs a full dollar out of pocket. This difference can influence how much money in absolute dollars a person can save. There also are no certainties that a person’s tax rate will be higher in the future. Finally, Roth 401(k) plans are not exempt from the required minimum distribution (RMD); distributions must be taken when a person turns 70 1/2. (Roth IRAs are not subject to the RMD rules, however.)

Charles Rotblut (@charlesrotblut) is a vice president with the American Association of Individual Investors.